Commentary: Markets are calm, but social strains are building

It’s often a last-ditch effort to avoid the inevitable, and that may be the position Spanish Prime Minister Mariano Rajoy is in.

The slow fuse of a corruption scandal involving payoffs to politicians in Rajoy’s conservative Popular Party — and allegedly to Rajoy himself — flared up this week after the Spanish daily El Mundo published text messages from the prime minister to a former party treasurer, urging him to “be strong” as prosecutors investigated him for running a slush fund.

The conventional wisdom has been that, as the euro
EURUSD, -0.87%
crisis strains fragile political coalitions in southern European countries, Rajoy is the exception, with a secure majority swept into office in 2011 as the Socialist Party bore the brunt of the initial political backlash against recession and austerity.

The security of that majority is being tested as the slush-fund scandal undermines the credibility of the government and makes it even more difficult to push through harsh spending cuts and economic reforms prescribed by European authorities in Brussels and Berlin.

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Opposition leader Alfredo Perez Rubalcaba, head of the Socialist Party, this week threatened to call a no-confidence vote unless Rajoy appears before Parliament to answer questions about the alleged slush fund. The move would be symbolic since the Popular Party majority ensures he would survive the vote, but neither alternative can be very appealing.

So Rajoy joins other southern European leaders on a tightrope as austerity policies plunge their countries into a deflationary spiral that appears to have no end.

After Portuguese Prime Minister Pedro Passos Coelho last week attempted to patch up his fraying coalition with a cabinet reshuffle, President Anibal Cavaco Silva instead gave him an ultimatum to reach a “national salvation pact” with the opposition or face new elections.

Even if all major parties, including the opposition Socialists, pledge support for the austerity program, Cavaco Silva said he will dissolve Parliament and call early elections when the program expires next June. The official term of the current Parliament runs to October 2015 at the latest.

The Portuguese parties set a deadline of July 21 to respond to Cavaco Silva’s demand, though it puts the Socialists in the difficult position of having to accept austerity measures they have criticized. Opposition leader Antonio Jose Seguro suggested they could only do so if terms were renegotiated with European authorities.

As it is, the Lisbon government has postponed a meeting with the troika — the European Commission, the European Central Bank and the International Monetary Fund — that was due to take place this month until late August.

Some analysts have interpreted the steadiness in Spanish bond yields, hovering near 4.7%, as a sign that neither the new pressure on Rajoy nor contagion from Portugal, where yields spiked at 7.8% before receding toward 7%, are having an impact.

Investors may be taking a short-sighted view, however. Rajoy’s efforts to impose structural reforms were difficult enough given resistance by Spain’s autonomous regions, and are doubly so when he is preoccupied with defending himself against charges of corruption.

And Alexander Ward at the Atlantic Council’s Brent Scowcroft Center for International Security warned in a recent blog post that political and economic strains could lead to a resurgence of separatist terrorism in Spain, not only in the Basque country, but in Catalonia and Galicia as well.

The social stress from an unemployment rate topping 25%, and especially a youth unemployment rate topping 50%, exacerbate separatist and extremist trends never far from the surface in Spain, Ward says.

It doesn’t help that the royal family, the guarantor of Spain’s political stability since Franco’s death in 1975, has itself become embroiled in a separate corruption scandal that may involve King Juan Carlos’s son-in-law.

Perhaps Rajoy can continue his stonewalling on his own corruption case as his party distances itself from its former treasurer. But new revelations could cause it to flare up again at any time.

Majority or no, Rajoy’s position, in short, has become more fragile, and further deterioration in the situation would have consequences for Spain and the euro.

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